Strategies for Trusts and Estates in New York

Transcription

1 I N S I D E T H E M I N D S Strategies for Trusts and Estates in New York Leading Lawyers on Protecting Clients Assets, Determining the Best Estate Planning Strategy, and Adapting to New Laws and Trends

2 2010 Thomson Reuters/Aspatore All rights reserved. Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, except as permitted under Sections 107 or 108 of the U.S. Copyright Act, without prior written permission of the publisher. This book is printed on acid free paper. Material in this book is for educational purposes only. This book is sold with the understanding that neither any of the authors nor the publisher is engaged in rendering legal, accounting, investment, or any other professional service. Neither the publisher nor the authors assume any liability for any errors or omissions or for how this book or its contents are used or interpreted or for any consequences resulting directly or indirectly from the use of this book. For legal advice or any other, please consult your personal lawyer or the appropriate professional. The views expressed by the individuals in this book (or the individuals on the cover) do not necessarily reflect the views shared by the companies they are employed by (or the companies mentioned in this book). The employment status and affiliations of authors with the companies referenced are subject to change. Aspatore books may be purchased for educational, business, or sales promotional use. For information, please West.customer.service@thomson.com. For corrections, updates, comments or any other inquiries please TLR.AspatoreEditorial@thomson.com. First Printing, If you are interested in purchasing the book this chapter was originally included in, please visit

3 Changes in Laws Affecting Estate Planning Thomas R. Amlicke Partner Siller Wilk LLP

4 Inside the Minds Published by Aspatore Books General Discussion of Tax Law Changes Every new year brings with it changes and opportunities. This is especially true in the estate tax planning realm of Changes to the federal estate tax laws in 2009 included, for example, the largest ever increase in the estate tax exemption. Effective January 1, 2009, the applicable exclusion amount (AEA), which is the amount excluded from federal estate tax, jumped from $2 million to $3.5 million. With this welcomed change, however, comes a significant state estate tax cost that requires revisiting one s estate plan to ensure that both federal and state estate taxes are reduced in an effective manner consistent with the client s objectives. Because of the increased AEA, the single client will be able to pass to his family or other beneficiaries $3.5 million without paying any federal estate tax. Furthermore, with proper estate planning, a husband and wife can shelter up to $7 million. However, flexibility in estate planning and the use of various wealth transfer techniques are of paramount importance due to the uncertainty of the future of the federal tax law, the marked volatility in asset values and interest rates, and, of course, possible changes in the client s personal life. The federal estate tax, for example, is scheduled to be repealed on January 1, 2010, only to return to an AEA of only $1 million in Despite the scheduled decrease in the AEA from $3.5 million to merely $1 million in only two years, most estate planning experts are of the opinion that the only certainty amid the uncertainty is that more changes are likely to come in 2009 for a number of reasons. One such change is preserving the $3.5 million AEA beyond 2009 and the current top tax rate of 45 percent, which the new administration supports. Regardless of the changes that will come about, we are confident that they will come this year, and estate planning attorneys must plan against unwanted or unexpected consequences. Although avoiding federal estate tax will be easier starting in because of the increased AEA, the same is not true with state estate tax. In fact, the 1 As noted above, the federal estate tax is scheduled to be repealed on January 1, 2010, only to return to an AEA of only $1 million in However, the law has a sunset provision, which means that if Congress passes no additional law, the estate tax laws in effect prior to the Tax Relief Act of 2001 would be reinstated in Gift tax rates will be reduced on the same schedule as the estate tax rate. However, when the estate tax is repealed in 2010, taxpayers will still be subject to a lifetime gift tax, with a maximum gift tax rate of 35 percent, which is the same as the maximum income tax rate. Gift tax rates are reduced on the same schedule as the estate tax rate. The generation-skipping transfer tax will also be repealed for all transfers after December 31, For purposes of this discussion, we will assume that the AEA will remain at $3.5 million.

5 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke increase in the federal AEA means that estates in 2009 (and beyond, if the anticipated federal changes become law by year s end) will be subject to a far greater state estate tax. While the higher AEA will result in lower federal estate taxes on the death of the surviving spouse, for example, it can also cause unanticipated state estate tax to be due at the death of the first spouse if your client s estate plan has not been updated to account for the possibility of differing federal and state estate tax exemptions. For residents of New York, 2 where the exclusion amount is only $1 million, if the estate plan is designed to minimize federal estate taxes only, there may be state estate tax liability of as much as $229,200 at the death of the first spouse. Consider this example: an estate of $2 million in 2008 paid no federal estate tax, while paying $99,600 in New York state estate tax (a similar estate tax would have been due in New Jersey and Massachusetts there was no estate tax in Connecticut because its exemption was $2 million); in 2009, an estate of $3.5 million will still not pay federal estate tax, but will incur as much as $229,200 in state estate taxes. Therefore, it is more important than ever for residents of a state with a state estate tax (or a resident of any state who owns real property in such a state, in some cases) to determine whether one s will and/or revocable trust should be updated, considering the likelihood that the federal and applicable state estate tax exemptions are different at the time of the death of the first spouse. Most traditional estate plans maximize the use of the federal AEA, resulting in no federal tax due at the death of the first spouse. However, as is evident from the example above, there could be a considerable state estate tax due. In some cases, but certainly not all, it may make sense in the long run to pay the relatively small amount of state estate tax at the first death to avoid possibly paying substantially more federal tax at the death of the surviving spouse. Since a federal and state estate tax will, in all likelihood, continue to be a reality for a long time, estate tax considerations will continue to be important for many clients. Flexibility in dealing with changes to the federal and state tax codes, and not predictability, is the key to an effective estate plan. At our firm, we urged our clients to contact us for a review of their estate plan to discuss the impact of the federal AEA increase and the various techniques available to maximize their objectives by minimizing their estate tax. Such a review is also important to ensure that the AEA increase does not result in an unintended decrease in the amount going to the surviving spouse and increase in 2 The same is true of residents of Connecticut, Massachusetts, and New Jersey, whose exemptions are $2 million, $1 million, and $675,000, respectively.

6 Inside the Minds Published by Aspatore Books the amount going to children, by way of a classic credit shelter formula, which would require the funding thereof with an amount equal to the deceased spouse s available AEA. For instance, if the deceased spouse s will left the AEA equally to children and the balance to the surviving spouse, the amount available to the surviving spouse would decrease as the AEA increased. For example, if the deceased spouse had a $5 million estate, the surviving spouse would have received $4 million when the AEA was $1 million and only $1.5 million when the AEA increased to $3.5 million. Additional changes that may affect your client s estate plan that are worth mentioning, but are beyond the scope of this chapter, include the increase in annual gift tax exclusion, increase in non-citizen spouse gift tax annual exclusion, and increase in the generation-skipping transfer exemption. As you may know, each year individuals are entitled to make gifts of the annual gift tax exclusion amount without incurring gift tax or using up any of their lifetime applicable exemption amount (which remains unchanged at $1 million) against estate and gift tax. Having been adjusted for inflation, the annual exclusion per donee in 2009 is increased from $12,000 to $13,000. With respect to gifts made to a non-citizen spouse, that annual exclusion amount has been increased to $133,000 in As for the generation-skipping transfer exemption, the amount of the exemption, just like the estate tax exemption, has been increased from $2 million to $3.5 million in Therefore, since both a husband and wife can use a separate $3.5 million exemption, up to $7 million will be exempt from the generation-skipping transfer tax for transfers from, for example, grandparents directly to grandchildren, or grandparents to qualified trusts created for the grandchildren s benefit. This permits skipping over a generation for estate tax purposes. Clearly, this provides a significant benefit, but an effective estate plan should consider all relevant issues, including federal and state estate tax issues, to ensure that the increase in generation-skipping transfer exemption will provide a substantial benefit to your client s descendants over time. As with the federal AEA, the generation-skipping transfer exemption is scheduled to be repealed as of January 1, 2010, and to return to $1 million in However, since the two exemptions are linked both in the amount and applicable tax rate, it is likely that the generation-skipping transfer tax exemption, like the estate tax exemption, will also remain at $3.5 million and at the current flat tax rate of 45 percent 3 under the anticipated changes expected under the new administration. 3 The generation-skipping transfer tax is not graduated, and the 45 percent applies to the first dollar subject to the tax.

7 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke Impact of the Economic Crisis Since we are on the topic of predicting the unpredictable, as a result of comments made by the current administration and members of Congress, it is also worth noting that there has been a great deal of speculation on what the future may hold for federal estate tax legislation. In no specific order of significance, examples include: allowing the portability of the AEA so married couples may make full use of their current combined AEA ($7 million) without the necessity of a credit shelter trust, and even if the first spouse to die does not have enough assets to fully utilize his or her estate tax exemption, or the executor underfunds the credit shelter disposition, the unused portion of the AEA would not be lost and would be available to the surviving spouse; 4 eliminating the deduction for state death taxes; curtailing, if not eliminating, certain discounts for lifetime gifts and/or bequests of family limited partnerships; allowing flexibility in Crummey powers 5 such that gifts to trusts would qualify for the annual exclusion amount; increasing the AEA for gifts from the current $1 million to $3.5 million; and requiring a minimum of 10 percent of the value of the remainder interest for grantor-retained annuity trusts, as is presently required for charitable remainder trusts. In addition to the foregoing, there were significant changes affecting our clients IRAs and 401ks, resulting from October 2008 s Emergency Economic Stabilization Act and December 2008 s Worker, Retiree, and 4 For example, if when the first spouse dies, that spouse only has $2 million of assets that can be covered by $2 million of the AEA, the $1.5 million of unused estate tax exemption would be carried forward to the surviving spouse to be utilized on such spouse s death. 5 Gifts to an irrevocable trust do not automatically qualify for the federal annual gift tax exclusion. A Crummey power is an estate planning tool utilized to allow gifts to an irrevocable trust to qualify for the federal annual gift tax exclusion. A Crummey power (which derives its name from Crummey v. Commissioner of Internal Revenue, 397 F.2d 82 (9th Cir. 1968)) is a provision contained in certain irrevocable trusts (the most common of which is an irrevocable life insurance trust) that permits specified trust beneficiaries to withdraw gifts that a grantor makes to the trust. This withdrawal power permits a gift to the trust to qualify as a present interest gift, which in turn qualifies it for the annual exclusion. Generally, the annual exclusion effectively exempts annual gifts up to the applicable exclusion amount per trust beneficiary from the federal gift tax. Over time, regular gifting to the trust will reduce the size of the grantor s gross estate. Without the Crummey power, all gifts made to the irrevocable trust (which, for example, if they are not withdrawn by the beneficiary, are often used by the trustee to pay for annual life insurance premiums) would otherwise be subject to gift tax.

8 Inside the Minds Published by Aspatore Books Employer Recovery Act. While the rules affected by the changes are too complex for, and beyond the scope of, this chapter, the major benefits are as follows. The Emergency Economic Stabilization Act allows individual taxpayers who are at least seventy and a half years old to exclude up to $100,000 annually of otherwise taxable IRA distributions that are paid directly to qualifying charitable organizations. The Worker, Retiree, and Employer Recovery Act suspends the application of the minimum distribution rules for 2009 as they apply to IRAs and defined contribution plans such as 401k and profit-sharing plans. This means that in most cases, owners of such accounts and the beneficiaries of deceased account owners will not be required to take a minimum distribution in Lastly, while the economic downturn in 2008 created an unsettling volatile market and interest rates reached historic lows, it also presents unique estate planning opportunities for 2009 and beyond. Simply put, the lower interest rates fall and the more stock prices decrease, the better the environment to transfer assets with reduced or no gift or estate tax consequences. This is true because many techniques rely on assets outperforming the Internal Revenue Service s rates of return. While there are a number of options available to our clients, two of the more common techniques that become significantly more valuable as the prices of securities and interest rates fall are sales to defective grantor trusts, and the use of grantor-retained annuity trusts. In addition to these, the Internal Revenue Service s low rates present real opportunities to allow clients to assist their families while shifting wealth between generations with reduced or no gift tax implications. Intra-family loans, for example, can provide a significant benefit to a junior generation family member with relatively modest tax implications to the senior generation family member. Not only can intrafamily loans be made at rates lower than those that are commercially available, but also the payment terms can be designed to fit the specific needs and resources of the borrower. The changes in 2009 and the educated speculation of future estate tax legislation present both the need to revisit one s estate plan and an unexpected opportunity to utilize techniques that will allow the practitioner to better structure his client s objectives while maximizing estate and gift tax savings. As a service to our clients, our trusts and estates practice group provides our clients with periodic updates to keep them abreast of

9 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke significant developments and opportunities that affect their existing estate plans, or that they should consider in developing their future estate plans. It is a practice that more estate planning attorneys should engage in. Not only is it good practice, but it is good for client development. Tax and Other Law Changes Affecting New York Estate Planning Increase in Federal Applicable Exclusion Amount 6 The most significant recent development affecting New York estate tax actually did not come about through the New York legislature. As briefly set forth above, in 2009, the AEA for the federal estate tax and generationskipping transfer tax increased from $2 million to $3.5 million. In 2010, the current law provides that there will be a repeal of the estate tax and the generation-skipping transfer tax. In 2011, the AEA and the generationskipping transfer tax exemption will revert back to $1 million, which was the amount prior to the current law. Although one can never accurately predict the future when it comes to Tax Code legislation, it is highly unlikely that the current administration and Congress, as it is constituted today, will allow the AEA to be repealed. It is also highly unlikely that the $3.5 million AEA will be reduced by future federal tax legislation. As unpredictable as Tax Code legislation may be, one thing is for certain: the New York Estate Tax Law will remain unchanged for the foreseeable future. In fact, the reason the 2009 federal change is so significant to New York state estates stems from the last major change affecting New York estate tax law, which was in 2005, as further discussed below. For residents of New York, 7 if the estate plan is designed to minimize federal estate taxes only, there may be state estate tax liability of as much as $229,200 at the death of the first spouse. Consider this example: An estate of $2 million in 2008 paid no federal estate tax, while paying $99,600 in New York state estate tax (a similar estate tax would have been due in New Jersey and Massachusetts there was no estate tax in Connecticut because its exemption was $2 million). In 2009, an estate of $3.5 million will still not 6 The following discussion also applies to other states that have decoupled their state estate tax provisions from the federal estate tax, and do not allow a state-only qualified terminable interest property. 7 The same is true of residents of Connecticut, Massachusetts, and New Jersey, whose exemptions are $2 million, $1,million, and $675,000, respectively.

10 Inside the Minds Published by Aspatore Books pay federal estate tax, but will incur as much as $229,200 in state estate taxes. In some cases, but certainly not all, it will make sense in the long run to pay some state estate tax at the first death to avoid possibly paying substantially more federal tax at the death of the surviving spouse. A New York resident 8 surviving spouse, for example, with her own taxable estate of $3.5 million, would save more than $900,000 in federal taxes in her estate by paying $229,200 in her husband s estate. 9 The relationship between the New York estate tax and the federal estate tax system changed dramatically in 2005 when New York became a decoupled state for federal estate tax purposes. As a result of this decoupling, assuming a taxable estate of at least $3.5 million, the death of a grantor or testator with a New York estate in 2009 and beyond may result in exposing at least $2.5 million (the difference between the federal AEA of $3.5 million and the New York AEA of $1 million) to New York estate tax. Therefore, there could be a significant New York estate tax even though there would be no federal estate tax due on a $3.5 million estate. The significance of January 1, 2005, is that it is the date that the pick-up tax was officially phased out under the provisions of the Economic Growth and Tax Relief Reconciliation Act. For dates of death on or after January 1, 2005, the Internal Revenue Code allows a deduction for state estate taxes (or inheritances taxes 10 paid to a state in computing the federal taxable estate). Prior to 2005, an estate was allowed a credit against the federal estate tax for such taxes. This change affects the New York state estate tax because New York state estate tax does not conform to the federal change. As a result, the deduction for state death taxes is not allowable in computing the taxable estate for New York State. 8 The example would also apply to residents of Connecticut, Massachusetts, and New Jersey, the difference being the proportionate state estate tax relative to the particular state s exemption. 9 For purposes of simplifying calculations, this example assumes that the predeceased spouse died in 2009 and the current federal and state AEA will remain the same. 10 For those not familiar with the difference, the distinction between an inheritance tax and an estate tax is that an inheritance tax is based on who inherits the decedent s property, as opposed to the total value of the estate. In other words, the tax is assessed only against the property the beneficiary receives, not the total value of the decedent s estate. For example, in a state that imposes an inheritance tax, a transfer to a spouse or to a charity is not taxed, a transfer to a child or other descendant is taxed at a rate different from that which would be applied to a transfer to a sibling, and yet another rate is applied to transfers made to anyone else. In New York, which does not vary the rate based on who inherits the property, full deductions are allowed for property passing to a surviving spouse who is a U.S. citizen or to a charity.

11 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke Since New York state tax law incorporated the increases in the unified credit up to the amount of tax on $1 million, the filing requirements for New York State were identical to the federal requirements through The additional increases in the federal filing threshold after 2003 were not incorporated in New York state tax law, so the filing threshold for New York State remains at $1 million. As such, some estates with dates of death after 2003 would have to file a New York state estate tax return, even if they are not required to file a federal estate tax return. So how does one know if a New York estate tax return is required to be filed? The answer 11 is as follows: If the date of death is on or after January 1, 2004: The estate must file Form ET-706, New York State Estate Tax Return, if any of the following conditions are true: The decedent was domiciled in New York State at the time of death, and the total of the federal gross estate, federal taxable gifts, and specific exemption (see federal instructions for Form 706) exceeds $1 million. The decedent was not domiciled in New York State at the time of death, and the estate includes real or tangible personal property with a situs in New York State, and the total of the federal gross estate, federal taxable gifts, and specific exemption exceeds $1 million. The decedent was neither a resident nor a citizen of the United States, the estate includes real or tangible personal property with a situs in New York State, and the estate is required to file a federal estate tax return (Form 706-NA). If the date of death was on or after February 1, 2000, but before January 1, 2004: The estate had to file Form ET-706, New York State Estate Tax Return, if both of the following were true: 11 See instructions for Form ET-706.

12 Inside the Minds Published by Aspatore Books The estate is required to file a federal estate tax return (either Form 706 or Form 706-NA). The decedent was domiciled in New York State (that is, a resident) at the time of death, or was a non-resident who owned real property or tangible personal property in New York state. Implications So, what does this change mean, and how does it affect a New York estate plan in 2009 and beyond? In the simplest of terms, there is a gap between the federal AEA ($3.5 million) and the New York AEA ($1 million) of $2.5 million. For married clients, this gap can result in a New York estate tax due on the first spouse s death, although no federal estate tax would be due until the death of the surviving spouse. The problem facing married clients in New York, therefore, is that your typical implementation of the marital deduction and the credit shelter trusts (commonly referred to as AB trusts) does nothing for minimizing New York estate taxes (or any other state s death estate taxes, for that matter). 12 Even more unfortunate for New York residents is the fact that although New York imposes its own estate tax and allows only a $1 million AEA, New York does not allow state-only qualified terminable interest property (QTIP) elections. Such an election would allow for a full federal estate tax exemption of $3.5 million for each spouse, while deferring all New York estate taxes until the surviving spouse s death. Since state-only QTIPs are not allowed in New York, New York residents are generally limited to either fully funding the federal estate tax exemption ($3.5 million) and paying New York estate taxes on the amount exceeding New York s AEA ($2.5 million) on the first spouse s death, or funding the credit shelter disposition with $1 million (New York AEA) and wasting $2.5 million of the federal estate tax exemption by overfunding the marital deduction disposition. As a result, the New York estate tax will be about $229,000 on 12 There are some states that allow for planning such that both the federal and state death taxes are deferred until the death of the surviving spouse through the use of what are commonly referred to as ABC trusts. New York is not one of those states. Therefore, New York residents without proper estate or post-mortem planning are faced with the choice of paying a state estate tax on the first spouse s death or under-funding the credit shelter trust so that both state and federal estate taxes are deferred until the death of the surviving spouse.

13 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke the $2.5 million of federal estate tax exemption exceeding the $1 million New York estate tax exemption. However, incurring some estate taxes upon the first spouse s death in exchange for fully utilizing the federal exemption may provide overall estate tax savings when considering the aggregate taxes payable for both spouses estates. Therefore, it would be a good idea to keep options open for your clients so that the executor can make the proper choice as to which estate assets would be used to fund state death taxes. But is there an even better alternative? Yes, there is. Here, too, however, we must rely on federal authority and not so much on New York authority. The issue is whether the estate of the surviving spouse will be afforded an exception to the Internal Revenue Code (I.R.C.) 2044 (West 2009) requirement that her estate include property for which a deduction was previously allowed with respect to the transfer of such property to the surviving spouse under I.R.C. 2056(b)(7) (1997). This summarizes the exception to I.R.C as provided in Rev. Proc , I.R.B (2001), and provides further observations and comments based on our review of private letter rulings and court decisions that have applied Rev. Proc and the pertinent sections of the Internal Revenue Code, generally. Background I.R.C. 2056(a), in pertinent part, provides that the value of a taxable estate is determined by deducting from the value of the gross estate an amount equal to the value of any interest in property that passes or has passed from the decedent to the surviving spouse. I.R.C. 2056(b)(7)(A) provides an exception to the terminable interest rule in I.R.C. 2056(b)(1) that denies a marital deduction for an interest passing to the surviving spouse that is a terminable interest. A QTIP, under I.R.C. 2056(b)(7)(A), is treated as passing to the surviving spouse, and no part of the property is treated as passing to any person other than the surviving spouse. Under I.R.C. 2056(b)(7)(B)(i), a QTIP is property that passes from the decedent, in which the surviving spouse has a qualifying income interest for life, and to which an election under I.R.C. 2056(b)(7)(B)(v) applies. Under I.R.C. 2056(b)(7)(B)(v), that election to treat property as QTIP under I.R.C.

14 Inside the Minds Published by Aspatore Books 2056(b)(7) is made by the executor on the return of tax imposed by I.R.C (2003). 13 Of course, this election, once made, is irrevocable. It goes without saying that a QTIP election has transfer tax consequences for the surviving spouse. Under I.R.C. 2044(a) and (b), the value of the surviving spouse s gross estate includes the value of any property in which the decedent has a qualifying income interest for life and with respect to which a deduction was allowed for the transfer of the property to the decedent under I.R.C. 2056(b)(7). 14 Therefore, in situations where an estate made an unnecessary QTIP election, the property subject to the election would unnecessarily enlarge the surviving spouse s gross estate under I.R.C. 2044(a), or if that spouse disposes of the income interest, would be subject to gift tax under I.R.C (West 2009). Further, the surviving spouse would, in the absence of a reverse QTIP election under I.R.C. 2652(a)(3) (1998), be treated as the transferor of the property for generation-skipping transfer tax purposes under I.R.C. 2652(a). The purpose of Rev. Proc is to provide relief for surviving spouses and their estates in situations where a predeceased spouse s estate made an unnecessary QTIP election under I.R.C. 2056(b)(7) that did not reduce the estate tax liability of the estate. Under certain narrow circumstances specified in the revenue procedure, the QTIP election will be treated as a nullity for federal estate, gift, and generation-skipping transfer tax purposes, so that the property will not be subject to transfer tax with respect to the surviving spouse. Applicability of Rev. Proc Certain QTIP elections will be disregarded for estate tax purposes. Specifically, the revenue procedure provides that QTIP elections that were 13 The term return of tax imposed by 2001 means the last estate tax return filed by the executor on or before the due date of the return, including extensions or, if a timely return is not filed, the first estate tax return filed after the due date. 14 Under I.R.C. 2519(a) and (b), any disposition of all or part of a qualifying income interest for life in any property with respect to which a deduction was allowed under I.R.C. 2056(b)(7) is treated as a transfer of all interests in the property other than the qualifying income interest. Further, the surviving spouse will, in the absence of a reverse QTIP election under I.R.C. 2652(a)(3), be treated as the transferor of the property for generation-skipping transfer tax purposes under I.R.C. 2652(a).

15 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke not necessary to eliminate federal estate tax on the first spouse s death will be ignored in determining the amount included in the surviving spouse s estate under I.R.C One example of an unnecessary QTIP election described in the revenue procedure is one that is made for both a credit shelter trust and a marital trust. The QTIP election for the credit shelter trust is not necessary, because no estate tax is imposed on a credit shelter trust funded with an amount that does not exceed the AEA under I.R.C. 2010(c) (2002) (i.e., $3.5 million). The unnecessary election will cause inclusion of both the credit shelter trust and the QTIP trust in the surviving spouse s estate on his or her subsequent death, potentially increasing the estate tax on his or her estate. In effect, by making the election, the executor has wasted the predeceased spouse s estate tax exemption. Rev. Proc provides that on the surviving spouse s subsequent death, the Internal Revenue Service will disregard the unnecessary election and will not insist on inclusion of the credit shelter trust assets in the surviving spouse s estate. Another example where, as a consequence of an unnecessary QTIP election, the property subject to the election would be included in the surviving spouse s estate under I.R.C. 2044, but for the protection of Rev. Proc , is where the election was made when the taxable estate (before allowances of the marital deduction) was less than the applicable exclusion amount under I.R.C. 2010(c). Obviously, the QTIP election was not necessary, because no estate tax would have been imposed regardless of whether the QTIP election was made. However, Rev. Proc states that it does not apply in situations where a partial QTIP election was required with respect to a trust to reduce the estate tax liability in the predeceased spouse s estate and the executor made the election with respect to more property than was necessary to reduce the estate tax liability to zero. Nor does it apply to elections that are stated in terms of a formula designed to reduce the estate tax to zero. Observations and Suggestions It appears that the revenue procedure allows for an opportunity to obtain the benefit of a marital deduction in the first spouse s estate without the accompanying tax burden in the surviving spouse s estate. Let us take a closer look.

16 Inside the Minds Published by Aspatore Books The revenue procedure sets forth the procedure by which the estate of the surviving spouse may avail itself of the revenue procedure s protection. In addition, although some may opine that it is automatic ab initio, the application of Rev. Proc is not automatic and applies only if the surviving spouse or the surviving spouse s estate applies for relief. Since an application for relief is required, it is possible to leave the difference between the federal AEA and the New York AEA in a separate QTIP Trust and make a QTIP election for that trust. When the surviving spouse dies, her estate would then decide whether to invoke Rev. Proc In that case, it is very likely to be impossible or impractical for New York State to collect the estate tax in the first spouse s estate. However, if New York State takes the position that the unnecessary QTIP election is void ab initio, it might seek to impose the tax on the predeceased spouse s estate despite the QTIP election. But, as discussed below, we do not believe this to be a likely scenario. So, by using Rev. Proc , is the family able to have its cake and eat it too? Does the revenue procedure mean the QTIP election can be used to avoid state estate tax on the first death, while the unnecessary QTIP trust is still excluded from the surviving spouse s estate? The answer would be probably so. When a taxpayer obtains relief under the revenue procedure, the QTIP election is disregarded, including for purposes of the marital deduction in the first spouse s estate. The ultimate reversal or undoing of the marital deduction may not incur any federal estate tax in the first estate. But without that deduction, New York state estate taxes would have been imposed on the first spouse s estate. It would appear, therefore, that the New York State Department of Taxation and Finance, upon learning of an application for relief under the revenue procedure, may assert a claim for tax in the first spouse s estate, along with interest and any other additions to tax. And, one could reasonably conclude, that as interesting an idea as it might be, the risk and reward would need to be considered because the taxing authority could decide to not allow the revenue procedure to maximize the federal estate tax savings and avoid the New York state estate tax in both the first and second estates.

17 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke Here is an example of a scenario in which the risk and reward would need to be contemplated: spouse dies and his revocable trust provides for a marital trust. We will assume that he did not make any lifetime taxable gifts. Therefore, his full estate tax exemption is available to the executor. He is survived by his wife and children, with a taxable estate of $4.5 million. Since the marital trust is of a kind that can qualify for the QTIP marital deduction (if the executor so elects), it will be exempt from estate tax to the extent that the executor elects. However, the tradeoff would be that the portion of the marital trust (or what remains of it at the surviving spouse s death) to which the election is made will be fully includible and taxable in the surviving spouse s eventual estate. The incremental estate taxes then attributable to the marital trust would be payable out of the assets of the marital trust, not out of the surviving spouse s general estate. In other words, the taxes on the death of the surviving spouse would be borne by the children, since they are the ultimate beneficiaries of the marital trust. The first option, in a scenario in which we do nothing until the death of the first spouse, which would involve no risk at all, would be for the executor to elect QTIP treatment for only $1 million of the marital trust, leaving $3.5 million uncovered by the marital deduction. The result would be that no federal estate tax is due because $3.5 million (the federal AEA) would be utilized for the credit shelter disposition and the balance will be covered by the marital deduction. However, $2.5 million (the difference between the federal and New York state AEA) would be exposed to New York estate tax, resulting in $229,000 in New York estate taxes. In the second option, 15 the trustee could exercise their power under the revocable trust agreement to divide the marital trust into three trusts we will refer to them as credit shelter trust, QTIP trust #1, and QTIP trust #2. The credit shelter trust would contain $1 million in assets. QTIP trust #1 would contain $2.5 million, and QTIP trust #2 would contain the balance of the marital trust assets, or $1 million. The executor could elect QTIP treatment for both QTIP trust #1 and QTIP trust #2, and leave the credit 15 The strategy discussed in this second option can be structured by creating multiple separate QTIP-able trusts for both spouses in their respective wills or revocable trusts so as to avoid having to wait for the first spouse to die, then having the trustee exercise their power to create separate trusts, thereby eliminating the alleged risk of the Internal Revenue Service determining that the post-mortem planning is akin to a partial election.

18 Inside the Minds Published by Aspatore Books shelter trust uncovered by the marital deduction. This option would result in no federal or New York estate tax because the credit shelter trust does not exceed the New York AEA and the QTIP trusts are covered by the marital deduction. The second option, therefore, leaves open the possibility under the revenue procedure that the surviving spouse s executor might be able to exclude QTIP trust #1 from her gross estate. If this works, the reward is that incremental estate taxes that would be charged against the marital trust would only be based on QTIP trust #2 (i.e., $1 million), and not both QTIP trusts. The second option would result in no federal or New York estate tax because, as mentioned above, Rev. Proc provides that where the estate of the first spouse to die has made a QTIP election with respect to a trust that was not necessary to reduce the federal estate tax to zero in that estate, the QTIP election with respect to that trust will be disregarded upon the surviving spouse s death and the value of that trust will not be included in the surviving spouse s gross estate. This would apply to our example because election of QTIP treatment for QTIP trust #1 would not be necessary to keep the federal estate tax in the estate at zero (this is so because had the QTIP election not been made, the $2.5 million, combined with the $1 million in the credit shelter trust, would not have exceeded the $3.5 million AEA). One might question whether the revenue procedure would work to keep our QTIP trust #1 from being included in the surviving spouse s estate since the revenue procedure states that it is inapplicable where a partial QTIP election was made with respect to a trust in the first spouse s estate. While there are no published rulings to indicate whether the Internal Revenue Service might regard the division of our marital trust into separate trusts, and the election of QTIP treatment for only two of the resulting three trusts, as a partial election, it is unlikely that the Internal Revenue Service, in a scenario where there would not have been any federal estate tax due, as in our example, would not allow the relief afforded under Rev. Proc What, then, of New York? Is there a risk? Here, too, there is no published ruling. However, we believe this is an opportunity in which the taxpayer would be permitted to have his cake and eat it too. The relief

19 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke afforded under the revenue procedure in the federal estate clearly results in excluding QTIP trust #1 from the surviving spouse s estate. But what of the fact that the first estate saved in New York estate taxes because of the very QTIP election that the executor of the second spouse s estate is now seeking to undo so that the corpus of QTIP trust #1 (or what is left of it) is not included in the surviving spouse s estate? What chance does New York have in recovering estate taxes against the first spouse s estate if the Internal Revenue Service allows the executor in the second spouse s estate to undo the election? The answer lies in N.Y. TAX LAW 961 (West 2009), Effect of Federal Determination. Specifically, said N.Y. TAX LAW 961(a)(3) states: a final federal determination as to the value or amount of any such item, shall also determine the same issue for purposes of the tax under this article unless such final federal determination is shown by a preponderance of the evidence to be erroneous (emphasis added). In other words, it would seem clear that the only way New York would be able to impose an estate tax on the first spouse s estate (assuming the statute of limitations on the first estate has run 16 ) upon the death of the second spouse is if the Internal Revenue Service s determination to allow the undoing of the QTIP election in the first spouse s estate was erroneous as a matter of law. It is difficult to imagine, if not impossible, a scenario in which the Internal Revenue Service erroneously determines the validity of a QTIP election. Therefore, once the Internal Revenue Service made its determination to allow the marital deduction in the first spouse s estate, New York would be bound by that determination. As a result, New York would not be able to impose its estate tax on the first spouse s estate, because to do so would necessarily involve retroactively imposing such a tax, which would be contrary to N.Y. TAX LAW 961. Significant Changes to Durable Power of Attorney A power of attorney is routinely recommended as part of an estate plan. It is very easily created and confers upon another a great deal of power over someone else s affairs. A general durable power of attorney, for example, is the only document one can use to effectively substitute the decision-making of the agent (attorney-in-fact) for that of the principal in virtually all types 16 There is a three-year statute of limitations (generally after the return is filed) on the Tax Department s right to assert additional tax due.

20 Inside the Minds Published by Aspatore Books of financial transactions. 17 Of course, with the broad power to act on another s behalf comes the fiduciary responsibility of exercising that power in the best interest of the principal. Unfortunately, there have been a number of attorneys-in-fact over the years that have failed to abide by their fiduciary duties and engaged in all sorts of impermissible acts of selfdealing. Effective September 1, 2009, however, 2008 N.Y. Sess. Laws ch. 644 (signed into law as Chapter 4 of the Laws of 2009) amends New York s General Obligations Law. N.Y. GEN. OBLIG. LAW (2009), which contained the previous statutory short form power of attorney, has been repealed in its entirety. New N.Y. GEN. OBLIG. LAW , A, and B have been added in its place. This amendment provides significant changes to the use and exercise of powers of attorney in the hopes of providing additional protections against some of the major abuses. Because of its easy creation and significant effect on the financial management of the principal, the legislature intended for the new power of attorney to remain flexible enough to allow the agent to carry out the principal s reasonable intentions while also containing clear and consistent direction for its effective use. Many had opined, for example, that the former power of attorney made it difficult for a principal to make an informed decision about what type of authority and how much authority to give an agent with respect to the management of the principal s daily financial affairs and the reorganization or distribution of the principal s assets in connection with financial and estate planning, obviously two very different and potentially conflicting purposes. The prior power of attorney, for example, did not indicate that the agent could engage in self-gifting or self-designation as the beneficiary of the principal s insurance policies and retirement benefits. In addition, some argued that gifting and transfer provisions were scattered among more routine provisions, and that clear and precise instructions as to gifting were nowhere to be found in the former power of attorney. Considering that the power of attorney could also be employed in matters involving the principal s medical bills, concerns were also raised with regard to the interaction of the prior law with federal privacy rules under the Health Insurance Portability and Accountability Act. 17 A general durable power of attorney is also an attractive method by which to avoid having to commence a N.Y. MENTAL HYG. LAW et seq. (West 2009) proceeding for the purpose of having a guardian of the person or property appointed for an incapacitated person.

21 Changes in Laws Affecting Estate Planning by Thomas R. Amlicke Specific Changes 1. Validity of the New Form The new law provides ample definitions for the terms used within Title 15. See N.Y. GEN. OBLIG. LAW And to prevent miscommunication and possible fraud, it also provides that a valid power of attorney must be (i) legibly typed in no less than twelve-point font, (ii) signed and dated by a principal, (iii) with capacity (as defined within the statute), (iv) in the manner prescribed for the acknowledgement of a conveyance of real property. See N.Y. GEN. OBLIG. LAW B. Moreover, the new form is not valid until it is signed by both the principal and agent, whereas the prior form merely required the duly acknowledged signature of the principal. Both signatures are required to be duly acknowledged. If there is one agent appointed, the effective date of the power of attorney is the date on which the agent s signature is acknowledged. If there are two or more agents, each of whom may act separately from the other, the effective date of the power of attorney as to a particular agent is the date on which that agent s signature was acknowledged. If two or more agents are designated to act together, the power of attorney takes effect when all the agents have signed and their signatures have been acknowledged. In addition, unless the principal expressly provides otherwise, co-agents must act together. However, even in the absence of an authorization for the agents to separately act, in certain emergency situations, as defined in the statute, one co-agent may serve alone. See N.Y. GEN. OBLIG. LAW (2009). To sign a power of attorney, the principal must have capacity, which is defined by the statute as the ability to comprehend the nature and consequences of the act of executing and granting, revoking, amending, or modifying a power of attorney, any provision in a power of attorney, or the authority of any person to act as agent under a power of attorney. See N.Y. GEN. OBLIG. LAW All powers of attorney are considered durable 18 unless the document expressly states otherwise. Accordingly, the 18 A durable power of attorney is one in which the power of attorney will continue to be effective even if the principal becomes incapacitated.

22 Inside the Minds Published by Aspatore Books non-durable power of attorney form has likewise been repealed. However, the new statutory form can be modified to indicate that the power of attorney should not survive the principal s incapacity. 2. Fiduciary Duties In addition to the statutory explanation of the agent s fiduciary duties, in essence codifying the common law recognition of an agent as a fiduciary, a notice is added to the statutory short form explaining the agent s role, fiduciary obligations, and legal limitations on authority. The agent s duly acknowledged signature serves as an acknowledgment of the agent s fiduciary obligations and evidences the agent s intent to accept the appointment and abide by those obligations. As had been the case previously, in transactions on behalf of the principal, the agent s legal relationship to the principal must be disclosed. The principal may also provide that the agent receive reasonable compensation for carrying out those transactions. An agent under power of attorney, however, is not entitled to compensation unless it is expressly provided for within the document. The statutory form provides a box to be initialed if the agent is to receive reasonable compensation. Reimbursements of the agent s expenses are permitted without an affirmative provision. 3. Gifting Generally The new law increases the amount of the gifting provision to match the amount under the Internal Revenue Code and adds a provision allowing gifting to a 529 account up to the annual gift tax exclusion. Gift-splitting provisions have also been amended to allow the principal to authorize the agent to make gifts from the principal s assets to a defined list of relatives, up to twice the amount of the annual gift tax exclusions, with the consent of the principal s spouse. The default statutory provisions regarding annual exclusions on gifting will remain consistent with federal law. 4. Major Gifts and Rider The most significant change to the law is the establishment of the statutory major gifts rider (SMGR), a supplemental document in which the principal may authorize major gift transactions and other transfers as